Mortgage bonds open the first day without the Fed's involvement in the MBS Purchase Program -34 basis points...or just over a .25% discount point worse. It appears their exit is already impacting the bond traders of the world whether this be a direct or tangible affect...or if bond traders are showing fear due to the exit.
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Post from 3/31/10
In short...they go UP!
On March 31st, 2010 the Federal Reserve ended it Mortgage Backed Security (MBS) purchase program. This so-called quantative easing is the mechanism that our government has used to lower and keep mortgage interest rates in the low 5% or sub 5% range for the past 18 months. Without this purchaser of MBS...we expect interest rates to go up beginning in April likely in slow manner but there sure could be some volatility. How much...who knows. I think high 5% to 6% range by year end. In short, beginning in April if you like your rate, LOCK IT. Do not get hopeful or greedy thinking rates could go lower. I'll explain why we feel they are going to go up in the following paragraphs.
I like to call Mortgage Backed Securities the investment vehicle the drives interest rates. MBS are bonds---a safer investment than its counterpart Stocks. What you should know about bonds are they have a price and a yield. The price is the cost to purchase the security and the yield is the rate of return on that investment (or interest rate). You may recognize this as it is a similar investment to a bank CD. A simple example would be for me to give $1000 to my bank to invest for 1 year in return for 2% interest. After 1 year, I get my $1000 back plus $20 (which is 2% of $1000). And to finish, a key to Bonds you must understand: when bond prices go up, yields (interest rates) go down. And when bond prices go down, interest rates go up.
In the case of MBS...you would invest money in a bond security that would pay a specific rate. The popular securities today are 4%, 4.5% and 5% MBS coupons. Let's try an example: You usually have large fund managers of 401k's or mutual funds that buy shares of MBS in specific coupon levels. So if PIMCO funds bought $100Million in MBS at 4.5% they hope to get their principal back at a later date when the security expires or the loan is paid off plus the interest of 4.5% on an annual basis.
The past 18 months, the FED has been buying MBS at the tune of 1.25 trillion dollars worth. I am not sure of the guidelines they gave in the actual purchases...but I can imagine that the goal was to make set purchases each week in different coupon increments regardless of the price of the MBS bond.
A simple lesson in economics and Supply vs. Demand: if you have an over abundance of a product the manufacturer may have to lower the price to move all of their goods. You create demand by making the product more affordable. On the flip side, let's say that you have too little of a product and can't get enough of the product into consumers' hands: prices may go up as consumers can be willing to pay more to get that product.
To tie it all together. When the FED stepped in and started buying 20 billion worth of MBS every week, there was a limited supply of MBS on the market for the normal players like your 401k and mutual fund providers. Prices began to go up and interest rates began to drop. People started buying homes or refinancing their home loans to lower interest rates. As people buy, more MBS are created for these new loans each month. And now that the FED is exiting their purchase program...there will be additional bonds on the market without as many buyers or as much money buying the bonds as there was the past 18 months. Ahhh---supply vs demand and what we call a Supply Issue!!!! The way to create demand for the over supply? To lower price...and increase yields. Investors will want more in return for their money...and we pay a higher interest rate for our mortgage as a result.
In summary...LOCK YOUR RATE IF YOU LIKE IT!!! It's not a time to wait around and see if your rate goes lower. Good luck and happy house hunting.
Ryan
ryanf@fairwaymc.com
http://myindymortgage.com/
Many people have asked how MBS relate to points. I have this video below to help explain.
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